RDP 2017-05: The Property Ladder after the Financial Crisis: The First Step is a Stretch but Those Who Make It Are Doing OK 1. Introduction

In recent years there has been an increasing focus on both the levels of household debt and the levels of housing prices in Australia. This focus is enlivened by both the experience of the financial crisis, particularly in the United States, and historical highs for both debt and housing prices. On the one hand, given increasing housing prices, there are concerns that households are taking on unsustainable levels of debt in the pursuit of home ownership. On the other hand, given that home ownership is seen as an important path to prosperity in Australia and ‘at the core of the Australian dream’ (House of Representatives 2015), declining home ownership is also viewed with alarm. Work on income inequality, for example, has highlighted a link between the increase in inequality over recent decades and patterns of home ownership.[1] These two conflicting concerns: that households might be taking on too much debt in the pursuit of home ownership, and that falling home ownership rates might be undermining the Australian dream, highlight how difficult it is to reach conclusions about the likely macroeconomic consequences of recent trends in housing prices and household debt. This paper is an effort to better understand these consequences.

Concerns over the level of debt have most commonly been expressed by reference to aggregate household debt-to-income ratios. In Australia, this ratio has risen from approximately 100 per cent of household income in 2000 to around 160 per cent as of December 2016. The general trend in other countries is similar (Figure 1).[2]

Figure 1: Aggregate Household Debt-to-income Ratios
Cross-country estimates
Figure 1: Aggregate Household Debt-to-income Ratios

Sources: National sources; OECD; RBA; Thomson Reuters

Notwithstanding this statistic's frequent use, it has a number of drawbacks. First, it compares a stock of debt with a flow of income rather than, say, a stock of debt against a stock of assets or a flow of repayments against a flow of income. This mixing of concepts means that it is not clear what a reasonable benchmark for the level of debt to income might be. There are also important distributional considerations that affect what meaning can be attached to the aggregate values. At heart these issues stem from the fact that, while it is tempting to interpret higher aggregate debt-to-income ratios through a representative consumer lens, it is misleading. Of particular note is that the aggregate ratio places more weight on high-income households, which can be misleading. Higher-income households can support higher debt-to-income ratios than lower-income households. This is primarily because a smaller fraction of a higher-income household's expenditure needs to be devoted to necessities leaving more available to spend on other things. There are also other dimensions in which borrowers may differ, such as their risk of unemployment and their ability to obtain funds in an emergency, that would affect the inherent riskiness of any given debt level. To overcome these problems, this paper uses household-level data from the Household, Income and Labour Dynamics in Australia (HILDA) Survey to better interpret the aggregate trends in household debt and better understand the forces driving household home ownership and debt decisions.[3]

We focus our analysis by looking at the first step on the property ladder – the transition from being a renter to a first home buyer (FHB) and the years immediately following this event. The reason for this focus is twofold. First, this is the step that is perceived as being one of the riskiest. FHBs typically have higher loan-to-valuation ratios and higher debt-servicing burdens than more established borrowers. Second, it allows us to focus on the life cycle of a household's debt and how the individual experience may differ from the aggregate. In this respect, the fact that FHBs tend to be at the start of their career means they might also expect stronger income growth in the future, which will affect their post-purchase experience. This is important because it is not possible to understand aggregate debt statistics without knowing what is happening to the individuals who make up that aggregate and their expectations for the future.

We also look at changes in FHB behaviour since the financial crisis. This is motivated by the possibility that the experience of the financial crisis has changed household risk tolerance and behaviour. For example, households may be more wary of taking on any new debt and this might be one explanation for declining rates of home ownership. Similarly, households may be more risk averse and more focused on paying down existing debt; as such, any given change in interest rates may have less of an effect on consumption and activity than it did prior to the crisis.

To address these questions we split our analysis into three stages: first we look at the factors that explain the initial decision to become an FHB; then we consider the amount of debt that FHBs take on; and, finally, we document the experience of FHBs in the years after they buy their first home. To provide some context for this analysis, however, we start with a summary of the public debate and previous research in this area.


See La Cava (2016) for a discussion of the effect of home ownership on wealth and income. [1]

While Australian debt levels are towards the upper end of these cross-country comparisons, cross-country comparisons are unreliable. For example, countries in which the government provides more services through higher taxation will tend to have higher debt-to-disposable income ratios than otherwise similar countries where these services are purchased on the private market. Similarly, different property tax regimes or urban structure can also affect the comparisons. As such, it is more important to focus on the trends in these comparisons than the levels. [2]

A more detailed description of the data used in this paper is contained in Appendix A. [3]